The first Starbucks opened its doors in Seattle, Washington in 1971 by three partners - English teacher Jerry Baldwin, history teacher Zev Siegle, and writer Gordon Bowker. stumbled upon an ideal location in the city's historic. They had bean coffees. Howard Schultz joined the company in 1981 as a Director of Marketing. On a trip to Italy soon after he started, Schultz had a transformational epiphany that would revolutionize the way Americans drink coffee. As he strolled up and down the piazzas of Milan, undoubtedly well-caffeinated, it struck him that the US currently did not offer a store format in which coffeedrinkers, book-enthusiasts, and conversationalists could converge over a cup of coffee, staying for a few minutes or a few hours. Upon his return to the US, he left Starbucks to start II Giornale coffechouses, which acquired Starbucks in 1988, and rebranded its own sites as Starbucks shops. From there, Starbucks experienced phenomenal growth as it expanded across the country. The firm went public in 1992 and opened operations internationally in 1996, with a store in Tokyo. In 2000 , after 13 years at the top, Schultz decided that he had led the company long enough and passed the reins to Orin Smith. A 10-year veteran of the company, Sryith had been promoted from within and appeared to be a natural fit to take over for Schultz. Starbucks did not lose any steam under Smith's leadership, even acquiring Seattle's Best in 2003. This helped strengthen their portfolio, as they were now able to offer a premium brand with Starbucks and an everyday brand with Seattle's Best. The executive post was too much for Smith, however, as he decided in 2005 that he wanted to "slow down" because of the intensity of the environment. Smith and Schultz had brought in Jim Donald in 2003 from Pathmark Stores as an eventual heir to the post, but the promotion came sooner than expected because of Smith's retirement. Under Donald's leadership, Starbucks began to veer away from its core focus of coffee by venturing into music contracts, book deals, and two Hollywood movies. These only generated modest success, however, and this lack of focus caused the stores to become cluttered with stuffed animals and CDs. Additionally, consumers started to notice that as they entered a Starbucks, their nostrils weren't filled with the familiar smell of fresh-brewed coffee, but rather fresh-baked breakfast sandwiches. These offered a profitable addition to the Starbucks menu, but overpowered the smell of the coffee, in addition to slowing down drive-thru orders and lengthening in-store lines. As Donald was reaching the end of his tenure, one of the things that became apparent was the escalation of operating expenses with respect to net revenues. Essentially, Donald was paying for the growth he was seeing, as operating expense growth outpaced net revenue growth in each of his three years at the helm. This eventually climaxed in 2008 as Starbucks' growth rate in operating expense almost doubled that in their revenue, which may have been the straw that broke the camel's back. This led to Donald's eventual ousting, and deep cuts in restructuring, which are discussed in depth in the next section. As the problems began to mount, the company shook up the executive staff, stripping certain duties from Donald (pictured below left, with Schultz) and transferring them to Martin Coles, chief operating officer. During Donald's tenure, the share price had fallen nearly 50% while competition from Dunkin Donuts amplified, and McDonald's began rolling out its successful McCafe platform. In the end, the rumblings were too much for Donald to overcome, and the board asked Schultz to return to the post in the his sights on two primary goals: closing underperforming domestic stores and shifting focus to international growth. While not as profitable as US stores, international locations had larger growth potential, and Starbucks had already saturated much of the domestic market. From 2006 to 2007, Starbucks had experienced incredible revenue growth of 21%, but it became obvious that they were buying much of that growth, with operating expenses also up 21%. From fiscal 2007 to fiscal 2008 , the operating expense increase significantly outpaced revenue growth, and resulted in a profit decline of over 50%. Upon Schultz's return in 2008 , he immediately implemented restructuring efforts which were focused on two key things. First, the old mantra of 'a Starbucks on every comer' proved to be an incredible way to quickly promote your brand name, but not a sustainable source of profit. Schultz was quoted as saying: It is the case that we have stretched the real estate selection process further than we have in the past in terms of demographics. And yes that has resulted in some attrition, so we will now open A team was assembled to pinpoint the least profitable stores, and these were shuttered. What remained, however, were the expenses related to early lease exits, HR-related costs of relocating employees, and asset impairment. In addition, the restructuring efforts were not limited to domestic stores, as the team decided to close 61 stores in Australia in an attempt to refocus its strategy there. The second major restructuring charge was related to the leadership and organizational changes, which required expensive buyout packages of multiple top executives. With the restructuring efforts in full swing, Starbucks also recognized that much of its future growth would come outside the borders of the United States. From 2009 to 2011, the company had a net contraction of 780 domestic stores. Intemationally, however, Starbucks had a net addition of over 1,100 stores. With a new, tighter focus, and store growth in the right places, Schultz believed Starbucks was poised for big things in 2009. What no one could have predicted towards the end of 2008 , however, was the subprime mortgage crisis, which led to a meltdown on the Wall Street and later on the Main Street. This had a tremendous impact on all consumers, especially those interested in a $4 Frappuccino. In fiscal 2009 , Starbucks not only saw a 6% decline in net revenue (its first as a company), but its restructuring charges also increased 25% year on year. Additionally, the firm saw its stock price bottom out at $6.94 in November of 2008 . Despite the decline in net revenue and increase in restructuring cost, the restructuring appeared to pay off, as the leaner Starbucks still managed to grow profit 24% in 2009 . With the restructuring nearly complete, Starbucks was poised for big things in 2010. A key metric for all retailers and restaurants is that of comp-store sales, which grew 7% domestically and 6% internationally. This shows us two key things: the growth did not come primarily from store openings as it had in the past, and that the leaner model was resulting in better sales for the enterprise. With more effective management, and a tighter focus on its core principles, Starbucks was getting more people in the door and was doing it at a faster pace. As the stock continued to soar, Schultz determined it was time to give back to investors who stuck with the firm through its restructuring efforts. In March of 2010 , with the price hovering around $24, the company declared a dividend of 10 cents a share, targeting a payout range of 35% to 40% of net income, to $.13/ share. Soon Starbucks increased its dividend 30% the next quarter With earnings growth of 132% in fiscal 2010 , it was hard to imagine that Starbucks could top that. In 2011 , however, the momentum continued as revenue growth continued to outpace operating expenses. Starbucks had another phenomenal year with 9% revenue growth and 32% earnings growth, all with just an 8% operating expense growth. The stock continued to respond, sitting at $37 as the fiscal year ended, which was much higher than $25.94 at which it started the year. a/Analyze the competitors, growth rates and who are the competitors stealing market share from? b/ What are the valuations versus current stock performance? c/Perform a sensitivity analysis Assumntinns Projecting Free CFs After-tax EBIT Depreciation and amortization Working capital Change in working capital Capital expenditures Project Free Cash Flow Finding share value using after-tax WACC methed PV (free cash flow, 2022-2027) in Oct. 2022 Terminal value of cash flows at year 2027 . PV(Terminal value) in 2022 Total market value of the firm's asets Total debt Total market value of the firm's equity Estimated stock price per share Finding share value aving APV PV (free cash flow, 2022-2027) in Oet. 2022 Terminal value of cash flows at year 2027 PV(Terminal value of cash flows after 2027) in 2022 Base-case firm value for an all-equity firm Value of debt Interest payment Interest tax shicld PV(tax sield, 2022-2027) in Oct. 2022 PV(Terminal value of tax shields after 2027) in 2022 Total PV of tax shields Exhibit 1 Exhibit 2 Exhibit 3 Exhibit 4 Finding share value using APV PV (free cash flow, 2022-2027) in Oct. 2022 \begin{tabular}{|l|llll|l|l|} \hline 31,257 & 32,101 & 32,688 & 34,883 & 37,043 & 39,043 & 41,043 \\ \hline \end{tabular} Terminal value of cash flows at year 2027 PV(Terminal value of cash flows after 2027 ) in 2022 Base-case firm value for an all-equity firm \begin{tabular}{|r|r|r|r|r|r|} \hline 541.00 & 42 & $43.50 & 44 & 47 & 48 \\ \hline 1281551 & 1332195 & 1421909 & 1534859 & 1741004 & 1874046 \\ \hline \end{tabular} Value of debt Interest payment Interest tax shicld PV(tax shield, 2022-2027) in Oct. 2022 PV(Terminal value of tax shields after 2027 in 2022 Total PV of tax shiclds Probability of financial distress Vulue loss if financially distressed Expected cost of financial distress APV Total debt Total market value of the firm's equity Estimated stock price per share \$ 39.00541.00 \begin{tabular}{|r|r|r|r|r|} \hline 14015 & 16832 & 16341 & 16348 & \\ \hline 14.015 & 16832 & 16341 & 16.348 & \\ \hline 42 & 543.50 & 44 & 47 & 48 \\ \hline \end{tabular} The first Starbucks opened its doors in Seattle, Washington in 1971 by three partners - English teacher Jerry Baldwin, history teacher Zev Siegle, and writer Gordon Bowker. stumbled upon an ideal location in the city's historic. They had bean coffees. Howard Schultz joined the company in 1981 as a Director of Marketing. On a trip to Italy soon after he started, Schultz had a transformational epiphany that would revolutionize the way Americans drink coffee. As he strolled up and down the piazzas of Milan, undoubtedly well-caffeinated, it struck him that the US currently did not offer a store format in which coffeedrinkers, book-enthusiasts, and conversationalists could converge over a cup of coffee, staying for a few minutes or a few hours. Upon his return to the US, he left Starbucks to start II Giornale coffechouses, which acquired Starbucks in 1988, and rebranded its own sites as Starbucks shops. From there, Starbucks experienced phenomenal growth as it expanded across the country. The firm went public in 1992 and opened operations internationally in 1996, with a store in Tokyo. In 2000 , after 13 years at the top, Schultz decided that he had led the company long enough and passed the reins to Orin Smith. A 10-year veteran of the company, Sryith had been promoted from within and appeared to be a natural fit to take over for Schultz. Starbucks did not lose any steam under Smith's leadership, even acquiring Seattle's Best in 2003. This helped strengthen their portfolio, as they were now able to offer a premium brand with Starbucks and an everyday brand with Seattle's Best. The executive post was too much for Smith, however, as he decided in 2005 that he wanted to "slow down" because of the intensity of the environment. Smith and Schultz had brought in Jim Donald in 2003 from Pathmark Stores as an eventual heir to the post, but the promotion came sooner than expected because of Smith's retirement. Under Donald's leadership, Starbucks began to veer away from its core focus of coffee by venturing into music contracts, book deals, and two Hollywood movies. These only generated modest success, however, and this lack of focus caused the stores to become cluttered with stuffed animals and CDs. Additionally, consumers started to notice that as they entered a Starbucks, their nostrils weren't filled with the familiar smell of fresh-brewed coffee, but rather fresh-baked breakfast sandwiches. These offered a profitable addition to the Starbucks menu, but overpowered the smell of the coffee, in addition to slowing down drive-thru orders and lengthening in-store lines. As Donald was reaching the end of his tenure, one of the things that became apparent was the escalation of operating expenses with respect to net revenues. Essentially, Donald was paying for the growth he was seeing, as operating expense growth outpaced net revenue growth in each of his three years at the helm. This eventually climaxed in 2008 as Starbucks' growth rate in operating expense almost doubled that in their revenue, which may have been the straw that broke the camel's back. This led to Donald's eventual ousting, and deep cuts in restructuring, which are discussed in depth in the next section. As the problems began to mount, the company shook up the executive staff, stripping certain duties from Donald (pictured below left, with Schultz) and transferring them to Martin Coles, chief operating officer. During Donald's tenure, the share price had fallen nearly 50% while competition from Dunkin Donuts amplified, and McDonald's began rolling out its successful McCafe platform. In the end, the rumblings were too much for Donald to overcome, and the board asked Schultz to return to the post in the his sights on two primary goals: closing underperforming domestic stores and shifting focus to international growth. While not as profitable as US stores, international locations had larger growth potential, and Starbucks had already saturated much of the domestic market. From 2006 to 2007, Starbucks had experienced incredible revenue growth of 21%, but it became obvious that they were buying much of that growth, with operating expenses also up 21%. From fiscal 2007 to fiscal 2008 , the operating expense increase significantly outpaced revenue growth, and resulted in a profit decline of over 50%. Upon Schultz's return in 2008 , he immediately implemented restructuring efforts which were focused on two key things. First, the old mantra of 'a Starbucks on every comer' proved to be an incredible way to quickly promote your brand name, but not a sustainable source of profit. Schultz was quoted as saying: It is the case that we have stretched the real estate selection process further than we have in the past in terms of demographics. And yes that has resulted in some attrition, so we will now open A team was assembled to pinpoint the least profitable stores, and these were shuttered. What remained, however, were the expenses related to early lease exits, HR-related costs of relocating employees, and asset impairment. In addition, the restructuring efforts were not limited to domestic stores, as the team decided to close 61 stores in Australia in an attempt to refocus its strategy there. The second major restructuring charge was related to the leadership and organizational changes, which required expensive buyout packages of multiple top executives. With the restructuring efforts in full swing, Starbucks also recognized that much of its future growth would come outside the borders of the United States. From 2009 to 2011, the company had a net contraction of 780 domestic stores. Intemationally, however, Starbucks had a net addition of over 1,100 stores. With a new, tighter focus, and store growth in the right places, Schultz believed Starbucks was poised for big things in 2009. What no one could have predicted towards the end of 2008 , however, was the subprime mortgage crisis, which led to a meltdown on the Wall Street and later on the Main Street. This had a tremendous impact on all consumers, especially those interested in a $4 Frappuccino. In fiscal 2009 , Starbucks not only saw a 6% decline in net revenue (its first as a company), but its restructuring charges also increased 25% year on year. Additionally, the firm saw its stock price bottom out at $6.94 in November of 2008 . Despite the decline in net revenue and increase in restructuring cost, the restructuring appeared to pay off, as the leaner Starbucks still managed to grow profit 24% in 2009 . With the restructuring nearly complete, Starbucks was poised for big things in 2010. A key metric for all retailers and restaurants is that of comp-store sales, which grew 7% domestically and 6% internationally. This shows us two key things: the growth did not come primarily from store openings as it had in the past, and that the leaner model was resulting in better sales for the enterprise. With more effective management, and a tighter focus on its core principles, Starbucks was getting more people in the door and was doing it at a faster pace. As the stock continued to soar, Schultz determined it was time to give back to investors who stuck with the firm through its restructuring efforts. In March of 2010 , with the price hovering around $24, the company declared a dividend of 10 cents a share, targeting a payout range of 35% to 40% of net income, to $.13/ share. Soon Starbucks increased its dividend 30% the next quarter With earnings growth of 132% in fiscal 2010 , it was hard to imagine that Starbucks could top that. In 2011 , however, the momentum continued as revenue growth continued to outpace operating expenses. Starbucks had another phenomenal year with 9% revenue growth and 32% earnings growth, all with just an 8% operating expense growth. The stock continued to respond, sitting at $37 as the fiscal year ended, which was much higher than $25.94 at which it started the year. a/Analyze the competitors, growth rates and who are the competitors stealing market share from? b/ What are the valuations versus current stock performance? c/Perform a sensitivity analysis Assumntinns Projecting Free CFs After-tax EBIT Depreciation and amortization Working capital Change in working capital Capital expenditures Project Free Cash Flow Finding share value using after-tax WACC methed PV (free cash flow, 2022-2027) in Oct. 2022 Terminal value of cash flows at year 2027 . PV(Terminal value) in 2022 Total market value of the firm's asets Total debt Total market value of the firm's equity Estimated stock price per share Finding share value aving APV PV (free cash flow, 2022-2027) in Oet. 2022 Terminal value of cash flows at year 2027 PV(Terminal value of cash flows after 2027) in 2022 Base-case firm value for an all-equity firm Value of debt Interest payment Interest tax shicld PV(tax sield, 2022-2027) in Oct. 2022 PV(Terminal value of tax shields after 2027) in 2022 Total PV of tax shields Exhibit 1 Exhibit 2 Exhibit 3 Exhibit 4 Finding share value using APV PV (free cash flow, 2022-2027) in Oct. 2022 \begin{tabular}{|l|llll|l|l|} \hline 31,257 & 32,101 & 32,688 & 34,883 & 37,043 & 39,043 & 41,043 \\ \hline \end{tabular} Terminal value of cash flows at year 2027 PV(Terminal value of cash flows after 2027 ) in 2022 Base-case firm value for an all-equity firm \begin{tabular}{|r|r|r|r|r|r|} \hline 541.00 & 42 & $43.50 & 44 & 47 & 48 \\ \hline 1281551 & 1332195 & 1421909 & 1534859 & 1741004 & 1874046 \\ \hline \end{tabular} Value of debt Interest payment Interest tax shicld PV(tax shield, 2022-2027) in Oct. 2022 PV(Terminal value of tax shields after 2027 in 2022 Total PV of tax shiclds Probability of financial distress Vulue loss if financially distressed Expected cost of financial distress APV Total debt Total market value of the firm's equity Estimated stock price per share \$ 39.00541.00 \begin{tabular}{|r|r|r|r|r|} \hline 14015 & 16832 & 16341 & 16348 & \\ \hline 14.015 & 16832 & 16341 & 16.348 & \\ \hline 42 & 543.50 & 44 & 47 & 48 \\ \hline \end{tabular}